China's accounting flaws open up an opportunity for India

A limping horse may still have a chance to win the race. How is that possible, you may ask. The answer is Einstein's theory of relativity. In a relative world, it does not matter if you are a bad horse as long as the other horses are in an even worse shape. Think of the global currencies and this analogy comes in pretty handy. With the limping horse we were referring to the US dollar. The greenback had everything going against it. Yet the US dollar has regained its safe haven status in recent times. How come? Because the Euro is in an even worse shape. Moreover, even China's growth has slowed down and many fear that the dragon economy is heading for a hard landing.

An economist by the name of Mr Gary Shilling even goes further to say that the US dollar would survive the global gloom and would continue to remain the primary international trading and reserve currency for decades. According to Mr Shilling, there are quite a many positives that the US economy has on its side such as its entrepreneurial bent, open economy, rapid productivity growth, superior technology and relatively open immigration. Besides these positives, the lack of alternatives to the greenback will aid its dominant global position.     


Crouching Tiger Wounded Dragon', a modified title for the Academy Award winning Mandarin movie, has often been used to denote the one-upmanship of Indian economy to its Chinese counterpart. Although China has proven to be a difficult competitor in every aspect, investors often benchmark India's performance against the dragon economy. Of late reports about the Chinese GDP growth rate slowing down, banks accumulating huge NPAs and real estate bubble threatening to burst have diverted investor focus from the juggernaut.

The latest to catch their attention is accounting flaws in large Chinese firms. Auditors expressing concerns over the irregularities and falsification of financial records in Chinese firms have left a bad taste in investors' mouth. As a result, FIIs have turned to Indian markets for better returns than the near zero interest rates back home. That the Indian capital market regulator SEBI has adopted more stringent laws for accounting disclosure seem to have added to their confidence. Smaller Indian companies looking to get themselves listed on the exchanges are also keen to tap this opportunity. It is now for the government and India Inc to ensure that investors looking for long term opportunities here do not get disappointed. Else most of the BRIC story will be gone for good.     

Why bankers may remain unpopular

Bankers the world over have been a maligned lot simply because they had a key role to play in creating the global financial crisis in the first place. Most of them (especially those in investment banks) focused on 'financial engineering' and creating complex products rather than stress on the basic sound principles of banking. Huge amounts of money were pocketed as bonuses for profits generated. But the bubble burst (as it was bound to) and the rest they say is history. Recession, bloated debt, large scale unemployment have all hampered the developed world and threatened the health of the global economy. But bankers do not seem to have learnt a lesson.

Indeed, rich bankers can today be exposed as a huge drain on society costing it £8.4 for every £1 they produce. A study by think-tank the New Economics Foundation found that the average banker destroys £42 m a year in value while creating just £5 m. As a result of the credit crunch, most big banks had to be bailed out and this has been a heavy drain on the tax payers' money. This is in contrast to public sector workers such as nursery workers and bin men who are lowly paid but produce more value than what they earn as wages. As long as bankers continue to pocket big salaries without contributing much to the economy, they are going to be extremely unpopular not just with the government but also with the public.    

IIP numbers don't matter in long run

The famous economist John Maynard Keynes once said that in the long run, we are all dead. It appears that the most of the investment community and financial media seems to have taken this comment rather seriously. What else will explain their fascination behind employing an entire battalion of analysts and economists in order to study the short term impact of an economic event of note? The end result? Extremely volatile share price movements and swings of the magnitude of 20%-30% becoming a common occurrence.

But is this approach correct? Certainly not if one realizes where does the value of stocks really come from and their longevity. There cannot be any ambiguity with respect to the fact that stocks are worth the present value of future cash flows they will deliver to their owners. But do they have an expiry date? Well, individual stocks may decline and the business models behind them disappear altogether. But if considered together as a group, their duration is extremely long and the dividends they pay out do certainly grow with time.

Thus, if we assume, like the famous asset management firm GMO has done, that half of the returns from stock in a given year come from dividends and half from growth in dividends, it becomes clear that most of the value of stocks comes from cash flows in the distant future. This is because dividend in any year will only be a very small fraction of the overall value accumulated over a very long term horizon.

Well, we will spare you the math here but the broad conclusion that comes out is that the first 11 years of dividend account for only 25% of the value of stock market. Thus, even if dividends are a whopping 50% below the trend over a period of 10 years, the value of the stock market will come down only by 10%. Contrast this with the 30%-40% corrections that stock markets regularly witness over a small downward revision in earnings or dividends and one understands why the markets are so irrational.

It is extremely important to add that if India's GDP grows by 6% instead of 8%, this does not mean that India's capacity to grow GDP by 8% has been impaired completely. It is just that demand for goods and services has grown by 6%. Thus, when the demand returns, the economy will certainly be in a position to absorb the higher production needed. In view of this, whenever events like fall in industrial output, which we have demonstrated to have no sizeable impact on overall valuation of stocks lead to market panicking and pushing down value of stocks by 30%-40%, rational, long term investors can take advantage of the same. They will thus benefit from the attractive above trend returns that lie in waiting for them.   

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Currency fluctuation and your investment!

Currency fluctuation

There are mainly two ways by which currency rates are managed. Firstly, countries fix their currency against dollar. Hence the exchange rate doesn't change. Government takes action to manage any fluctuation that may happen. Secondly, countries leave it to the market to decide their exchange rate. In such a system, countries follow policy of non-interference.

India doesn't have a fixed value of rupee against dollar but it also doesn't keep its currency completely floating against dollar. We have a system where the central bank allows rupee to fluctuate within a specified range.
Usually, rupee appreciation is taken as economy gaining strength while depreciation is taken as Indian economy losing strength.

How it impacts investors

Let's look at how rupee fluctuation impacts investors' decisions. Let's look at appreciation first.

Rupee appreciation -

Rupee appreciation is considered bad for companies where major part of their revenue comes from export. Appreciation of rupee makes products more expensive for export. When the products become expensive, importing nations either reduce the import or look out for other nations that can produce the same product at cheaper prices. Hence, any appreciation in rupee is often accompanied with clamour by export companies to devalue the currency.

Rupee appreciation is good for companies that depend on import from other countries. For example, oil companies, Parma, Engineering, and medical device companies will be fine with rupee appreciation. The machinery, oil, and engine used in such industries will be cheaper to buy. Investors can consider investing in such companies when rupees appreciate.

Let's take an example. Suppose the rupee dollar exchange rate is 50 (i.e. Rs 50 - $1). A company in export sector earns a profit margin of 15% from export. If the rupee appreciates and the new exchange rate is Rs 40 = $1. In this case, the company has lost 20% of the income.

This impacts investors in sectors that depend on export for their income. The typical examples are software industry and textile. Their dependence on export is heavy. Any rupee appreciation will hit software and textile industries hard. We have seen what happened in 2008 when America went into recession, dollar lost value and rupee appreciated against dollar. There were lay-offs, increased hours, flat revenues, and reducing profit. Investors in export oriented sector will be hit by any appreciation in rupee.

Rupee depreciation -

Rupee depreciation is when it loses value against dollar. For a nation like India where import is more than export, rupee depreciation makes things worse because imports get expensive. This increases the deficit. Rupee depreciation is not a good signal except for export driven companies.

For Indian economy, which depends on oil import, any fall in rupee will impact its oil bill. This will increased inflation because of increased oil bill. Increased inflation eats into the returns of investors. Moreover, a high inflation reduces the economic activity and consumption.

Software companies, textile companies, and many other export driven sectors such as tourism are the ones where investors can think of investing. Their export becomes cheaper and hence they can sell more to the overseas clients. These companies will do well.

Important points to keep in mind

Since the global crisis is yet to stabilize, there will be extreme fluctuation of currency or rupee. Greek crisis, Eurozone, America's growth, and many other factors will impact the currency rate. The most recent example is rupee's fall from Rs 44 a dollar to Rs 48 a dollar within a month. This happened because Euro went down against dollar as a result of Greek crisis. As a consequence dollar improved not only against euro but against many currencies. Investors are requested to trade based on currency fluctuation only when they have some expertise in this.

There will be times when rupee fluctuation may not impact individual companies or sectors because of other factors present. For example, if rupee depreciates against dollar further, there is not much chance that software industry will improve its income as they did in the past. They have become quite matured and going from here to the next level will require different ways to develop software.

Finally, the rupee dollar exchange rate will remain volatile till the crisis persists. Hence investors should practice caution when investing in exchange rate sensitive sectors.

Stock Investing – Short Term Strategies

There was a research conducted in United States on the average number of days investors hold the stock. The number was 187 (about 6 months) in 1991-1996 period. The median was worse with just 90 days. With internet boom era and overpriced IPOs in 2000s, this came down to about 3 months. There is no data available for Indian market but looking at the volatility of our stock market, the numbers will be very close or even less.

This tells us there are mostly short term traders in the market. Is there anything wrong with short term trading? Absolutely not, but investors should know the rules of the game before they trade short term. Apart from knowing the rules, investors should also understand that short term trading mostly relies on luck and on study, which at best can be termed speculative.

In the current volatile market scenario, you could be tempted to try your luck in some short term investment strategies to make the best out of a bad situation. Here is an understanding of some short term trading strategies usually followed by short term traders. Knowing these strategies will make you aware of your own actions. However, do proceed with caution.

Day-trade in stocks

In this trading style, traders buy and sell the stocks on the same day or in a very short period of time. The traders take advantage of daily market volatility to profit. They buy when the stock prices go down hoping the prices to appreciate in the day. They square-off by the end of the day. This can result in profit or loss depending on whether the price they sold at was higher or lower than their buy price. This is a very popular way to trade. The popularity stems from the fact that this looks exciting. Even if traders lose money, the loss doesn't seem big as daily variation is not very volatile.

Day-trading, however, is the most popular way to lose money. Majority of day-traders either lose money or do not make better than a long term investor. Investors look at daily loss and assume that this is not a big loss but accumulate the losses for the year and they can see the big picture.

Take an example. If I have 1 lakh and I gamble, I will be happy to earn Rs 2000 from my gamble. However, I will not be too worried if I lose Rs 2000. This psychology works against traders. The happiness to get marginal profit is more than the sorrow of suffering a marginal loss. Take another example. A buyer goes to a showroom and to buy a car worth 3 lakh. At the last moment, he comes to know that the seller is giving Rs 6000 coupon free to be spent in lifestyle. At the same time, another buyer goes to another shop and buys the car at 2 lakh and 94000 rupees. Both come out of the shop. Whom do you think will have bigger smile?

Risk mitigation

Investors should not put all their money in day-trading. If you are too excited by daily price volatility and want to try your hands in day-trading, put at most 10% of your total investment for this and play with this. Do not gamble more.

Trading on margin

In margin trading, the investor spends some part from his or her pocket and borrows the rest from the broker at an interest. In this context, investors have to understand the concept of initial and maintenance margin. Initial margin is the % of total investment that investors have to put. When the prices go down, your contribution in terms of percentage will go down. After it goes below a certain percentage, the broker will ask you to put more money to take it to the initial margin. This "certain percentage" is called maintenance margin.

Take an example. Let's say an investor, Rakesh buys 100 stock of Airtel at Rs 400 a share. The initial margin is 25% and maintenance margin is 10%. This means Rakesh has to put 10,000 (25% of total investment of 40,000). The rest 30,000 is borrowed by broker. Suppose the prices start going down and goes to Rs 330 a share. In this case, the total value is 330*100 = Rs 33,000. Let's calculate what the contribution by investor at this point is. The investor contribution is (33000-30000)/33000. This is less than 10%. Hence investor will get a call to put more money so that his or her contribution is 25% of Rs 33000 which is Rs 8250. Since his amount is 3000, he will have to deposit another 5250.

This is high risk high return strategy. The advantage is that if the prices go up, you earn all the profit minus the interest you pay to the broker on his contribution. However, the loss is equally yours because the broker will anyway charge the interest. This is a double whammy.

Risk Mitigation

The only risk mitigation strategy is that the investors should never put more money when margin call is given by the broker. The investor, instead, should ask the broker to square off the position with whatever loss has happened. Avoid the temptation to put more money after the margin call.

Selling short

In this short term strategy, investors borrow and sell the shares and later they have to buy this from open market and give it back to the lender. The idea is to benefit from decreasing prices. Investors short-sell stocks because they assume that prices will go down and when it goes down they buy it cheaper and give it back. The difference is the profit to investors.

Take an example. An investor Rakesh expects the price of Airtel with current market price @400 to go down. Since he has no stocks, he borrows 100 Airtel stocks from the market and sells it immediately earning 40,000. After sometime, as he expected, the Airtel price went down to 350. He buys 100 stocks back at 35,000 and gives it back. He earns Rs 5000 from this transaction. We are ignoring transaction costs and other charges for the sake of simplicity.

Short term is tempting to investors. Short term trading offers excitement, action, and instant gratification. Compared to this, long term is boring, tedious, and requires extreme patience. However, there is no way to build wealth but by using long term strategies. This is true for most of the investors. There are short term investors who have done tremendously well but they are few and far between. Hence investors should put their major portion of investment corpus for long term wealth building assets and segregate a minor portion for short term speculation.

Vedanta completes Cairn India deal

Vedanta Resources Plc (LSE:VED.L -NewsVED.L) completed its long-delayed $8.7 billion purchase of a majority stake in Cairn Energy Plc's (LSE:CNE.L - NewsCNE.L) Indian unit, more than a year after the deal was first announced, in a move that turns India-focused Vedanta into a diversified resources group.

London-listed Vedanta now holds 58.5 percent of Cairn India (:CAIL.NSCAIL.NS), it said on Thursday, of which 20 percent is held through its Sesa Goa (:SESA.NSSESA.NS) unit.

Cairn Energy, which will retain a 22 percent stake in Cairn India, confirmed it would return around $3.5 billion to shareholders.

Cairn Energy agreed in August last year to sell a majority stake in Cairn India to Vedanta. But the sale, one of the largest in India's energy sector, was delayed for months due to a disagreement over royalty payments.

"Today marks a key milestone for Vedanta as it puts to bed a deal drawn out for well over a year that has contributed to underperformance on fears of deal terms uncertainty and balance sheet stress," analysts at Liberum said in a note.

"Oil has been a solid performer over the course of 2011 ... we see the Cairn India inclusion as the key factor in repairing Vedanta's balance sheet and boosting bottom-line performance."

(Reporting by Clara Ferreira-Marques; Editing by David Holmes)

Food inflation rate falls to near 3-1/2 yr low

India's annual food inflation eased to its lowest in nearly three-and-a-half years in late November, driven by a sharp fall in prices of vegetables and protein-rich food, bolstering the case for a pause in rates when the RBI reviews policy next week.

Food inflation sharply eased to 6.60 percent in the year to November 26, government data on Thursday showed, from an annual 8.00 percent in the previous week.

New crop arrivals in the market have broadly pushed down vegetable prices, with potatoes leading the fall with a more than 4 percent drop in the latest week. Prices of protein-rich items like eggs, meat and fish also fell by more than 1 percent.

The annual fuel inflation remained unchanged at 15.53 percent in the latest week, data showed.

"There are seasonal advantages in place which explains the declining trend in food inflation. This was expected, but the only issue is this could partly be offset by the impact of the weak rupee on core inflation," said Shubhda Rao, chief economist with Yes Bank.

India Debt Crisis vs Euro Crisis

The European debt crisis seems never ending with both Germany and France lowering expectations for a deal to save the Euro at the upcoming European Union summit. The European Central Bank (ECB) has agreed to act as a lender of last resort only on the condition that governments show credible fiscal consolidation. A similar situation might be arising in India.

India's fiscal situation is getting out of hand. The country's fiscal deficit reached almost 71% of its full-year target in the first half of the year. This cast doubts over the government's ability to meet budget goals as federal finances feel the pressure of squeezed revenues and slowing growth. The government is set to fall short of its fiscal deficit target of 4.6% of GDP for 2011-12 by at least 1% and this will take the deficit to 5.6%, higher than the 5.1% deficit seen in 2010-11. The Reserve Bank of India (RBI) has been consistently warning the government about the worsening fiscal situation. But the government has so far ignored the RBI's warning and has failed to implement any kind of reforms with respect to food, fuel, fertiliser and power subsidies. It has also made no progress in improving the tax to GDP ratio. The government subsidy bill in the current fiscal is likely to go up by a massive Rs 1 trillion from Rs 400 bn on account of higher outlays towards fertiliser, food and oil.

But what is more worrying is the worsening fiscal situation of states. The states' fiscal position is also getting into a mess with expected losses of Rs 1 trillion of SEBs (State Electricity Boards) having to be borne by state governments. State level fiscal deficit will exceed 2.2% of GDP projected for 2011-12 if the SEB losses are taken into consideration. As a result India's total debt to GDP ratio is expected to increase from 65% to more than 70% in FY12.

So unless urgent reforms are undertaken by the government, the fiscal situation is not likely to improve any time soon. In fact with economic growth slowing down, revenues to the government might also take a hit, thus adding to the fiscal woes. It is time for the government to end policy paralyses and take some hard decisions. Any slippage on the fiscal gap target has the potential of worsening India's inflationary woes and choking private investment.

step by central banks is not a lasting solution

Recently, the central banks of some developed countries like the US, Canada, Japan, Switzerland, Britain and the European Central Bank (ECB) have agreed to lower the cost of existing dollar swap lines by 50 basis points. Sounds Greek? Well, we don't want to confuse you more by getting into the nitty-gritty of the matter. The important point here is that this will make it easier and cheaper for the troubled European banks to make dollar loans. So far, they were finding it expensive to do this and had little choice but to sell euros. This in turn hammered the value of the euro and also restricted credit in Europe. And now, this new development will make dollars easily accessible to European banks. The central banks seem to think that this measure will prevent a cred it crunch from striking the glob al economy.

But will this solve the European debt crisis? Not at all. The problem with central banks across the globe is that they have been trying in vain to solve a problem of excess leverage by more leverage. But homoeopathy doesn't work in the world of economics. By infusing more liquidity into the system, one can only expect to delay and worsen a looming crisis and fuel inflation. There is not going to be any real solution for the Eurozone economies without some painful touch reforms. And that calls for a lot of political will which seems to be totally lacking.